Fixing OFGEM, the UK’s Gas and Electricity Regulator

Date: 16/05/17

Dr John Constable: GWPF Energy Editor

There is likely to be increasing pressure to reform the gas and electricity regulator, Ofgem, which is widely held to have failed in the protection of consumers. This accusation is to a large degree both misguided and unjust. Ofgem is constrained by its Statutory Duties, which were revised by Ed Milliband in 2010 to put climate policy costs beyond criticism. It is this, as much as institutional lassitude, that accounts for it being so ineffective a consumer champion.

In the wake of concern about rising electricity retail prices to domestic households, the Conservative Party has suggested a price cap on Standard Variable Tariffs. It is fair to say that this policy has not been well received by commentators and economists, who with very good reason believe it likely to be counterproductive. Whether the voting public will be persuaded that a price cap is in their long-term interest remains to be seen, but it could well prove popular. – With a maladroit sense of timing that is typical of the hapless energy industry my own electricity and gas supplier has just sent me a letter explaining that due to price rises next year’s annual dual fuel bill is likely to be about 8% higher. Doubtless many other households are receiving similar news, and perhaps thinking positively about Mrs May’s offer to stamp on rip-off tariffs.

One, more sophisticated, reaction to this sort of news is to blame the regulator, Ofgem. If the government needs to wade in to protect consumers, surely the regulator must have failed in its job. This is an understandable conclusion, but to a very significant degree it is unjust to Ofgem, which is itself tightly regulated by the legal definition of its Statutory Duties and powers. These are defined in the Gas Act 1986, the Electricity Act 1989, the Utilities Act 2000, the Competition Act 1998, the Enterprise Act 2002, the Business Protection from Misleading Marketing Regulations 2008 and the Unfair Terms in Consumer Contracts Regulations 1999, and, crucially, in amendments to these acts. Perhaps the most important of these amendments occurred in the Energy Act of 2010, which originated under Ed Miliband when he was Secretary of State at the Department of Energy and Climate Change. Though a small change, it drew the regulator’s teeth.

The Utilities Act 2000 had described the overarching principal objective for energy regulation as the protection of the interests of existing and future consumers, wherever appropriate by promoting competition (for further details see this DECC analysis). This was a lucid and unconstricting brief. A determined regulator could range far and free in the pursuit of consumer welfare.

The Energy Act of 2010 amended this principal objective by defining “interests” thus in two separate paragraphs (16 (3) 1A and 17 (3) 1A referring to gas and electricity:

Those interests of existing and future consumers are their interests taken as a whole, including—

(a) their interests in the reduction of gas-supply/electricity supply emissions of targeted greenhouse gases; and

(b) their interests in the security of the supply of gas/electricity to them.

This change was of enormous importance, since an increasingly large part of the charges on the consumer were (and still are) the result of policy. In effect, the revision to Ofgem’s principal purpose made them unable to comment on the imposition of cost increases resulting from measures to mitigate climate change. Since these coercive cost increases are invisible to the market and cannot be reduced by competition, there was no means other than the regulator, or the slow and uncertain cycles of electoral democracy, to expose them to criticism.

This is no trivial matter. Policies now account for about 17% of the price to domestic households, in other words about £26/MWh of a total price to household consumers of £154/MWh (see the Committee on Climate Change Energy Prices and Bills). Median annual domestic electricity consumption in the UK is approximately 3.5 MWhs per household, so this amounted to about £91 per household per year, or roughly £2.4 billion a year, assuming 26 million households, a sum that greatly exceeds the £1.5 billion a year rip-off that prompted Mrs May to suggest a price cap.

According to the government’s estimates, in the now discontinued Estimated Impacts, we can see that this problem is set to grow dramatically. In 2020 the domestic price impact will have in all probability doubled, to £52/MWh, or about £180 a year on the electricity bill, a nationwide cost of about £5 billion per year.

Constrained by its remit, as set out by Ed Milibands Energy Act of 2010, Ofgem is powerless to comment on these enormous impositions. In essence, by being compelled to have regard to the interests of future consumers in the light of climate change the regulator has been absorbed by government and, like the Committee on Climate Change, made a mere cog wheel in the policy delivery mechanism. Consequently, and with the sole exception of the National Audit Office, there is no statutory body that has any interest in holding the government to account on climate policy costs, and none that is exclusively focused on the energy sector.

Restoring Ofgem’s Statutory Duties to their earlier free-ranging state could yield enormous benefits for the consumer. Such a reform should also be supported by electricity retailers, who, for all their faults, are carrying the can for climate policy related price increases over which they have no control. By contrast, a ‘reform’ of Ofgem that further weakened an already crippled body would be a disaster for all concerned.